Tax Cuts for Top 10% Has No Effect on GDP - New Study

New Study Finds High-Income Tax Cuts Don’t Stimulate Economic Growth

Congressional Republicans and their party’s presidential nominee have both pushed plans to cut taxes on the wealthiest Americans in hopes that such a move would stimulate the economy and aid the recovery from the Great Recession. A new study, however, indicates that tax cuts for the wealthiest earners fail to generate economic growth at the same pace as tax cuts aimed at low- and middle-income earners.The study, conducted by Owen M. Zidar, a former staff economist on President Obama’s Council of Economic Advisers and a graduate student at California-Berkeley, examined economic growth in the states with the most high-income earners. Zidar reasoned that “states with a large share of high income taxpayers should grow faster following a tax cut for high income earners” if the tax cuts had the economic effect conservatives claim.What he found, though, is that the effect of tax cuts for the rich was “insignificant statistically,” as Reuters’ David Cay Johnston reported:“Almost all of the stimulative effect of tax cuts,” Zidar found, “results from tax cuts for the bottom 90%. A one percent of GDP tax cut for the bottom 90% results in 2.7 percentage points of GDP growth over a two-year period. The corresponding estimate for the top 10% is 0.13 percentage points and is insignificant statistically.”Zidar’s study provides more empirical backing to what the U.S. has experienced over the last 30 years. Supply-side tax cutting policies have not led to the growth their Republican proponents promised. The Bush tax cuts, for instance, were followed by the weakest decade for economic expansion on record.Still, Republicans, some of whom admit that the Bush tax cuts didn’t lead to the desired growth, are sticking to their ideology. Republican presidential nominee Mitt Romney proposed a tax cut that is four times larger than the Bush tax cuts; the GOP has fought efforts to allow the high-income tax cuts expire at the end of the year, arguing that doing so would dampen growth; and Republican governors across the country have pushed tax cut packages aimed at the wealthy even as their states struggle with budget shortfalls.

Which tax cuts stimulate the economy?

Tax cuts are the key to job creation, or so Mitt Romney, running mate Paul Ryan and the 2012 Republican platform all say. But what does the empirical evidence show? Is the rhetoric in line with the known facts?

Studies examining the impact of cutting personal income tax rates on job growth or economic activity generally have been inconclusive, said Will McBride, chief economist for the Tax Foundation.

Owen M. Zidar, a graduate economics student at the University of California at Berkeley, and a former staff economist on the White House Council of Economic Advisers for President Obama, has taken another crack at it, sifting through the data, using the National Bureau of Economic Research’s tax simulation model. Zidar looked at state level income and economic data.

He reasoned that “if tax cuts for high income earners generate substantial economic activity, then states with a large share of high income taxpayers should grow faster following a tax cut for high income earners.” The data show that tax cuts at the top, though, do not not result in faster growth in states with more more high-earners.

“Almost all of the stimulative effect of tax cuts,” Zidar found, “results from tax cuts for the bottom 90%. A one percent of GDP tax cut for the bottom 90% results in 2.7 percentage points of GDP growth over a two-year period. The corresponding estimate for the top 10% is 0.13 percentage points and is insignificant statistically.”

Asked about the new research, Romney campaign spokeswoman Andrea Saul urged against publishing a story about Zidar’s work because it is preliminary and because of Zidar’s connection to the Obama Administration. Zidar has also worked for an arm of Bain Capital, the firm where Romney made a fortune in private equity.

That fits with the argument made over the last century by a variety of business leaders — carmaker Henry Ford and retailer Edward Filene among them — that the path to economic growth lies in workers making enough (and having enough after taxes) to buy goods and services.

University of California, Berkeley - Department of EconomicsJuly 24, 2012

Abstract: This paper investigates how tax changes for different income groups affect macroeconomic activity. Using historical tax return data from NBER’s TAXSIM, I construct a measure of who received (or who paid for) postwar tax changes for each income and payroll tax change that Romer & Romer (2010) classify as exogenous. At the national level, I aggregate tax changes for all taxpayers in the the bottom 90% and the top 10% of AGI and relate these aggregates to output, employment, and consumption growth. At the state level, I construct Bartik instruments for state tax shocks using national tax changes and each state’s share of high income taxpayers. If tax cuts for high income earners generate substantial economic activity, then states with a large share of high income taxpayers should grow faster following a tax cut for high income earners. I find that the negative relationship between tax changes and real GDP growth over a two year period is almost entirely driven by tax changes for the bottom 90%. The empirical relationship between tax cuts for the top 10% percent and job creation is negligible in magnitude, statistically insignificant, and much weaker than that of equivalently sized tax cuts for the bottom 90%.Number of Pages in PDF File: 26Keywords: Tax Cuts, Heterogenous Agents, Fiscal Policy, Paradox of Thrift, Business CyclesJEL Classification: E32, E62, H20, N12working papers series